helath net Q3

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helath net Q3

  1. 1. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 04:04 DISK037:[99WLA8.99WLA1958]BE1958A.;7 DISK037:[99WLA8.99WLA1958]BE1958A.;7 mrll.fmt Free: 1540DM/0D Foot: 0D/ 0D VJ JC1:1Seq: 1 Clr: 0 5 C Cs: 60934 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 1999 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 1-12718 FOUNDATION HEALTH SYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 95-4288333 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 21650 Oxnard Street, Woodland Hills, CA 91367 (Address of principal executive offices) (Zip Code) (818) 676-6978 Registrant’s telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: The number of shares outstanding of the registrant’s Class A Common Stock as of November 8, 1999 was 118,950,245 (excluding 3,194,374 shares held as treasury stock) and 3,305,242 shares of Class B Common Stock were outstanding as of such date. FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: BE1958A.;7 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  2. 2. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 05:28 DISK037:[99WLA8.99WLA1958]BG1958A.;5 DISK037:[99WLA8.99WLA1958]BG1958A.;5 mrll.fmt Free: 2790DM/0D Foot: 0D/ 0D VJ RSeq: 1 Clr: 0 5 C Cs: 53283 FOUNDATION HEALTH SYSTEMS, INC. INDEX TO FORM 10-Q Page Part I—FINANCIAL INFORMATION Item 1—Financial Statements Condensed Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998 . . . 3 Condensed Consolidated Statements of Operations for the Third Quarter Ended September 30, 1999 and 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 1999 and 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1999 and 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Item 3—Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . 27 Part II—OTHER INFORMATION Item 1—Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Item 2—Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Item 3—Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Item 4—Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Item 5—Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Item 6—Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 2 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: BG1958A.;5 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  3. 3. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 04:04 DISK037:[99WLA8.99WLA1958]DE1958A.;9 DISK037:[99WLA8.99WLA1958]DE1958A.;9 mrll.fmt Free: 220DM/0D Foot: 0D/ 0D VJ RSeq: 1 Clr: 0 5 C Cs: 21834 PART I—FINANCIAL INFORMATION Item 1. Financial Statements FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in thousands) September 30, December 31, 1999 1998 (Unaudited) ASSETS Current Assets: Cash and cash equivalents . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . $ 675,918 $ 763,865 Investments—available for sale . . . . . ........ . . . . . . . . . . . . . . . . . . 525,567 525,082 Premiums receivable, net . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 187,114 230,157 Amounts receivable under government contracts . . . . . . . . . . . . . . . . . . . 298,370 321,411 Deferred taxes . . . . . . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 209,569 160,446 Reinsurance and other receivables . . . ........ . . . . . . . . . . . . . . . . . . 135,529 147,827 Other assets . . . . . . . . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 106,048 91,096 Total current assets . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 2,138,115 2,239,884 Property and equipment, net . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 289,511 345,269 Goodwill and other intangible assets, net ........ . . . . . . . . . . . . . . . . . . 922,513 977,910 Deferred taxes . . . . . . . . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . — 118,759 Other assets . . . . . . . . . . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . 158,032 181,447 Total Assets . . . . . . . . . . . . . . . . . . ........ . . . . . . . . . . . . . . . . . . $3,508,171 $3,863,269 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Reserves for claims and other settlements . . . . . . . . . . . . . . . . . . . . . . . . $1,067,765 $1,006,799 Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91,874 288,683 Notes payable and capital leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,531 1,760 Amounts payable under government contracts . . . . . . . . . . . . . . . . . . . . 52,293 69,792 Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 297,943 458,397 Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,512,406 1,825,431 Notes payable and capital leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,084,349 1,254,278 Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,302 — Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,540 39,518 Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,652,597 3,119,227 Stockholders’ Equity: Common Stock and additional paid-in capital . . . . . . . . . . . . . . . . . . . . . 643,161 641,945 Treasury Class A common stock, at cost . . . . . . . . . . . . . . . . . . . . . . . . . (95,831) (95,831) Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . (1,971) (7,308) Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310,215 205,236 Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855,574 744,042 Total Liabilities and Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . $3,508,171 $3,863,269 See accompanying Notes to Condensed Consolidated Financial Statements. 3 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DE1958A.;9 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  4. 4. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 04:04 DISK037:[99WLA8.99WLA1958]DE1958B.;4 DISK037:[99WLA8.99WLA1958]DE1958B.;4 mrll.fmt Free: 1895DM/0D Foot: 0D/ 0D VJ RSeq: 2 Clr: 0 5 C Cs: 34735 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) Third Quarter Ended September 30, 1999 1998 (Unaudited) REVENUES Health plan premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,761,510 $1,769,291 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 372,778 348,732 Investment and other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,010 20,441 Net loss on sale of businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (23) — Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,161,275 2,138,464 EXPENSES Health plan services . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 1,495,784 1,551,072 Government contracts/Specialty services . . ..... . . . . . . . . . . . . . . . . . . . 244,326 232,346 Selling, general and administrative . . . . . . ..... . . . . . . . . . . . . . . . . . . . 314,008 354,706 Depreciation . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 17,574 20,276 Amortization . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 10,505 12,323 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 20,737 23,626 Restructuring, asset impairments and other costs . . . . . . . . . . . . . . . . . . . . — 71,687 Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,102,934 2,266,036 Income (loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58,341 (127,572) Income tax provision (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,252 (38,953) Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,089 $ (88,619) Basic and diluted earnings (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.29 $ (0.73) Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,310 122,133 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,733 122,133 See accompanying Notes to Condensed Consolidated Financial Statements. 4 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DE1958B.;4 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  5. 5. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 04:04 DISK037:[99WLA8.99WLA1958]DG1958A.;5 DISK037:[99WLA8.99WLA1958]DG1958A.;5 mrll.fmt Free: 1135DM/0D Foot: 0D/ 0D VJ RSeq: 1 Clr: 0 5 C Cs: 25271 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data) Nine Months Ended September 30, 1999 1998 (Unaudited) REVENUES Health plan premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,277,588 $5,331,922 Government contracts/Specialty services . . . . . . . . . . . . . . . . . . . . . . . . . . 1,105,882 1,017,595 Investment and other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,643 70,035 Net gain on sale of businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,725 — Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,498,838 6,419,552 EXPENSES Health plan services . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 4,470,578 4,527,221 Government contracts/Specialty services . . ..... . . . . . . . . . . . . . . . . . . . 725,220 657,388 Selling, general and administrative . . . . . . ..... . . . . . . . . . . . . . . . . . . . 950,597 1,033,412 Depreciation . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 52,350 58,189 Amortization . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 32,033 36,756 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . . . . . . . . . . . . . 63,332 67,680 Restructuring, asset impairments and other costs . . . . . . . . . . . . . . . . . . . . 21,059 121,687 Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,315,169 6,502,333 Income (loss) before income taxes and cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183,669 (82,781) Income tax provision (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,273 (21,356) Income (loss) before cumulative effect of change in accounting principle . . . . 110,396 (61,425) Cumulative effect of change in accounting principle, net of taxes . . . . . . . . . . 5,417 — Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 104,979 $ (61,425) Basic and diluted earnings (loss) per share: Income (loss) before cumulative effect of change in accounting principle . . . . $ 0.91 $ (0.50) Cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . 0.05 — Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.86 $ (0.50) Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,274 121,903 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,431 121,903 See accompanying Notes to Condensed Consolidated Financial Statements. 5 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DG1958A.;5 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  6. 6. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM SARAMAY//13-NOV-99 04:04 DISK037:[99WLA8.99WLA1958]DG1958B.;7 DISK037:[99WLA8.99WLA1958]DG1958B.;7 mrll.fmt Free: 655DM/0D Foot: 0D/ 0D VJ RSeq: 2 Clr: 0 5 C Cs: 14766 FOUNDATION HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Nine Months Ended September 30, 1999 1998 (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............ $ 104,979 $ (61,425) Adjustments to reconcile net income (loss) to net cash used in operating activities: Amortization and depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,383 94,945 Net gain on sale of businesses and real estate . . . . . . . . . . . . . . . . . . . . . . . (54,585) — Cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . 5,417 — Asset impairments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 47,000 Other changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,855 7,384 Changes in assets and liabilities, net of effect of dispositions: Premiums receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,778 (33,583) Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (195,150) (109,871) Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,051 (50,676) Amounts receivable/payable under government contracts . . . . . . . . . . . . . 5,542 (10,205) Reserves for claims and other settlements . . . . . . . . . . . . . . . . . . . . . . . . 72,229 (92,995) Accounts payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . (169,204) (34,977) Net cash used in operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (35,705) (244,403) CASH FLOWS FROM INVESTING ACTIVITIES: Sale or maturity of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504,713 606,755 Purchase of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (519,092) (570,899) Net purchases of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . (26,478) (105,580) Net proceeds from the sale of businesses and buildings . . . . . . . . . . . . . . . . . . 126,568 — Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,989 10,360 Net cash provided by (used in) investing activities . . . . . . . . . . . . . . . . . . . . . . 115,700 (59,364) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options and employee stock purchases . . . . . . . 1,216 12,789 Proceeds from issuance of notes payable and other financing arrangements . . . 141,275 125,560 Repayment of debt and other non-current liabilities . . . . . . . . . . . . . . . . . . . . (310,433) (4,046) Net cash provided by (used in) financing activities . . . . . . . . . . . . . . . . . . . . . . (167,942) 134,303 Net decrease in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . (87,947) (169,464) Cash and cash equivalents, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . 763,865 559,360 CASH AND CASH EQUIVALENTS, END OF PERIOD $ 675,918 $ 389,896 See accompanying Notes to Condensed Consolidated Financial Statements. 6 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DG1958B.;7 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  7. 7. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958A.;19 DISK037:[99WLA8.99WLA1958]DI1958A.;19 mrll.fmt Free: 75D*/120D Foot: 0D/ 0D VJ RSeq: 1 Clr: 0 5 C Cs: 30042 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The following notes should be read in conjunction with the notes to the consolidated financial statements and the Management’s Discussion and Analysis of Financial Condition and Results of Opera- tions for each of the three years in the period ended December 31, 1998 incorporated by reference in the Foundation Health Systems, Inc. (the ‘‘Company’’) Annual Report on Form 10-K for the year ended December 31, 1998 as well as the consolidated operating results presented in the Management’s Discus- sion and Analysis contained in this Quarterly Report on Form 10-Q. Note 1—Basis of Presentation In the opinion of management, the accompanying condensed consolidated financial statements include all normal and recurring adjustments necessary for a fair presentation of the consolidated financial position of the Company and the consolidated results of its operations and its cash flows for the interim periods presented. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the ‘‘Commission’’) applicable to quarterly reports on Form 10-Q. Results of operations for the interim periods are not indicative of results to be expected for the full year. Certain prior period amounts have been reclassified to conform with the current period presentation. In the second and third quarters ended June 30, 1999 and September 30, 1999, respectively, the Company reclassified and adjusted certain intercompany revenues and expenses which did not impact net income or earnings per share. In addition, in the first quarter ended March 31, 1999, the Company reclassified medical management expenses from health plan medical expense to selling, general and administrative expenses (‘‘SG&A’’) and also recorded SG&A expenses of its Specialty services businesses in SG&A, rather than in Specialty services costs as had been the case in prior periods. Note 2—Restructuring, Asset Impairments and Other Costs The following sets forth the principal components of restructuring, asset impairments and other costs for the three and nine months ended September 30 (amounts in millions): Three Months Nine Months Ended Ended September 30, September 30, 1999 1998 1999 1998 Severance and benefit related costs . . . . . . . . . . . . . . . . . . . ....... $— $21.2 $18.5 $ 21.2 Asset impairments and other charges related to FPA Medical Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....... — 28.1 — 78.1 Real estate lease termination costs . . . . . . . . . . . . . . . . . . . . ....... — 0.8 Other costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ....... — 22.4 1.8 22.4 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $— $71.7 $21.1 $121.7 1999 CHARGES The Company initiated a formal plan to dispose of certain Central Division health plans included in the Company’s Health Plan Services segment in accordance with its anticipated divestitures program in the 7 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958A.;19 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  8. 8. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958A.;19 DISK037:[99WLA8.99WLA1958]DI1958A.;19 mrll.fmt Free: 1205D*/2210D Foot: 0D/ 0D VJ RSeq: 2 Clr: 0 5 C Cs: 60231 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 2—Restructuring, Asset Impairments and Other Costs (Continued) fourth quarter of 1998. In this connection, the Company announced its plan to close the Colorado regional processing center, terminate employees and transfer its operations to the Company’s other administrative facilities. In addition, the Company announced its plans to consolidate certain administrative functions in its Northwest health plan operations. During the quarter ended March 31, 1999, the Company recorded pretax charges for restructuring and other charges of $21.1 million (the ‘‘1999 Charges’’). The following table summarizes the 1999 Charges by type (amounts in millions): 1999 Activity Balance at Excepted 1999 Cash September 30, Future Cash Charges Payments Non-Cash 1999 Outlays Severance and benefit related costs . . . . . . . . $18.5 $(5.8) $— $12.7 $12.7 Other costs . . . . . . . . . . . . . . . . . . . . . . . . . . 1.8 (0.8) — 1.0 1.0 Real estate lease termination costs . . . . . . . . . 0.8 (0.8) — — — Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $21.1 $(7.4) $— $13.7 $13.7 SEVERANCE AND BENEFIT RELATED COSTS—The 1999 Charges included $18.5 million for severance and benefit related costs related to executives and operations employees at the Colorado regional processing center and operations employees at the Northwest health plans. The operations functions include premium accounting, claims, medical management, customer service, sales and other related departments. The 1999 Charges included the termination of a total of 773 employees. As of September 30, 1999, 388 employees had been terminated and $5.8 million had been paid. Termination of the remaining 385 employees is expected to be completed during the first half of 2000. No adjustments to the original estimates have been recorded as of September 30, 1999. REAL ESTATE LEASE TERMINATION AND OTHER COSTS—The 1999 Charges included $0.8 million to terminate real estate lease obligations and $1.8 million in other costs to close the Colorado regional processing center. 1998 CHARGES During 1998, the Company recorded charges primarily related to the bankruptcy of FPA Medical Management, Inc. (‘‘FPA’’), the centralization and consolidation of the Company’s corporate finance and human resources functions, and the impairment of certain long-lived assets held for disposal as a result of the Company’s anticipated divestiture program approved in the fourth quarter of 1998. 8 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958A.;19 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  9. 9. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958A.;19 DISK037:[99WLA8.99WLA1958]DI1958A.;19 mrll.fmt Free: 90D /120D Foot: 0D/ 0D VJ RSeq: 3 Clr: 0 5 C Cs: 60353 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 2—Restructuring, Asset Impairments and Other Costs (Continued) The following two tables summarize the 1998 charges by quarter and by type (amounts in millions): Activity through December 31, 1998 1999 Activity Balance at Balance at Expected 1998 Cash December 31, Cash September 30, Future Cash Charges Payments Non-Cash 1998 Payments Non-Cash 1999 Outlays Severance and benefit related costs . . . . . . . . . $ 21.2 $ (13.2) $ (1.9) $ 6.1 $ (4.9) $ — $ 1.2 $1.2 Asset impairment and other charges related to FPA . . 84.1 (11.0) (63.5) 9.6 (5.6) (0.4) 3.6 0.6 Asset impairment and other costs . . . . . . . . . . . . . . 112.4 — (102.3) 10.1 (0.8) (3.1) 6.2 — Other costs . . . . . . . . . . . 22.4 (2.1) (9.6) 10.7 (1.4) (9.0) 0.3 0.3 Total . . . . . . . . . . . . . . . $240.1 $ (26.3) $(177.3) $36.5 $(12.7) $(12.5) $11.3 $2.1 Second Quarter 1998 Charge . . . . . . . . . . . . $ 50.0 $ (4.5) $ (41.1) $ 4.4 $ (4.4) $ — $— $— Third Quarter 1998 Charge . 71.7 (17.1) (33.9) 20.7 (6.5) (9.1) 5.1 2.1 Fourth Quarter 1998 Charge . 118.4 (4.7) (102.3) 11.4 (1.8) (3.4) 6.2 — Total . . . . . . . . . . . . . . . $240.1 $ (26.3) $(177.3) $36.5 $(12.7) $(12.5) $11.3 $2.1 SEVERANCE AND BENEFIT RELATED COSTS—During the third quarter ended September 30, 1998, the Company recorded severance costs of $21.2 million related to staff reductions in selected health plans and corporate centralization and consolidation. This plan includes the termination of 683 employees in 7 geographic locations primarily relating to corporate finance and human resources functions and California operations. As of September 30, 1999, 570 employees had been terminated and termination of the remaining 113 employees is expected to occur during the fourth quarter of 1999. No adjustments to the original estimates have been recorded as of September 30, 1999. FPA MEDICAL MANAGEMENT—On July 19, 1998, FPA Medical Management, Inc. (‘‘FPA’’) filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its affiliated medical groups, provided services to approximately 190,000 of the Company’s affiliated members in Arizona and California and also leased health care facilities from the Company. FPA has discontinued its medical group operations in these markets and the Company has made other arrangements for health care services to the Company’s affiliated members. The FPA bankruptcy and related events and circumstances caused management to re-evaluate the decision to continue to operate the facilities and management determined to sell the 14 properties, subject to bankruptcy court approval. Management immediately commenced the sale process upon such determination. The estimated fair value of the assets held for disposal was determined based on the estimated sales prices less the related costs to sell the assets. Management believed that the net proceeds from a sale of the facilities would be inadequate to enable the Company to recover their carrying value. Based on management’s best estimate of the net realizable values, the Company recorded charges of $50.0 million during the second quarter of 1998, $28.1 million during the third quarter of 1998 and $6.0 million during the fourth quarter of 1998. These charges were comprised of $63.0 million for real estate asset impairments, $10.0 million impairment adjustment of a note received as consideration in connection with the 1996 sale of the Company’s physician practice management business and $11.1 million for other items. These other items included payments made to 9 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958A.;19 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  10. 10. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 20D*/660D Foot: 0D/ 0D VJ RSeq: 4 Clr: 0 5 C Cs: 15664 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 2—Restructuring, Asset Impairments and Other Costs (Continued) Arizona physician specialists totaling $3.4 million for certain obligations that FPA had assumed but was unable to pay due to its bankruptcy, advances to FPA to fund certain operating expenses totaling $3.0 million, and other various costs totaling $4.7 million. The carrying value of the assets held for disposal totaled $12.4 million at September 30, 1999. There has been no further adjustment to the carrying value of the assets held for disposal during 1999. As of September 30, 1999, 10 properties have been sold which has resulted in net gains of $4.4 million during 1999 and $3.6 million in 1998 which are included in investment and other income. The remaining properties are expected to be sold during the fourth quarter of 1999. The suspension of real estate depreciation has an annual impact of approximately $2.0 million. ASSET IMPAIRMENT AND OTHER CHARGES—During the fourth quarter ended December 31, 1998, the Company recorded impairment and other charges totaling $112.4 million. During the fourth quarter of 1998, the Company initiated a formal plan to dispose of certain Central Division health plans included in the Company’s Health Plan Services segment in accordance with its previously disclosed anticipated divestitures program. The sale of most of these health plans has occurred during the nine months ended September 30, 1999 with the remaining health plans and real estate expected to be sold by the end of 1999. The Company evaluated the carrying value of the assets for these health plans and the related service center and holding company, and determined that the carrying value of these assets exceeded the estimated fair value of these assets. Estimated fair value was determined by the Company based on the then current stages of sales negotiations, including letters of intent, definitive agreements, and sales discussions, net of expected transaction costs. In the case of the service center and holding company operations, buildings, furniture, fixtures, equipment and software development projects were determined by management to have no continuing value to the Company, due to abandoning plans for development of this location and its systems and programs as a centralized operations center. Accordingly, in the fourth quarter of 1998, the Company adjusted the carrying value of these long-lived assets to their estimated fair value, resulting in a non-cash asset impairment charge of approximately $112.4 million. This asset impairment charge of $112.4 million consisted of $40.3 million for write-downs of abandoned furniture, equipment and software development projects, $20.9 million for write-down of buildings and improvements, $30.0 million for write-down of goodwill and $21.2 million for other impairments and other charges. The fair value was based on expected net realizable value. Revenues and pre-tax income attributable to these plans identified for disposition were $202.5 million and $76,000, respectively, for the nine months ended September 30, 1999. The carrying value of these assets as of September 30, 1999 was $45.8 million. No subsequent adjustments were made to the carrying value of these assets in 1999. The annual impact of suspending depreciation of these assets is approximately $13 million. OTHER COSTS—During the third quarter ended September 30, 1998, the Company recorded other costs totaling $22.4 million which included the adjustment of amounts due from a third party hospital system that filed for bankruptcy which were not related to the normal business of the Company totaling $18.6 million, and $3.8 million related to other items such as fees for consulting services to be provided by one of the Company’s prior executives and costs related to exiting certain rural Medicare markets. In addition to the above, other charges totaling $103.3 million were recorded in the third quarter ended September 30, 1998. These charges mostly related to contractual adjustments, equitable adjustments relating to government contracts, payment disputes with contracted provider groups and premium defi- ciency reserves and were primarily included in health care costs within the consolidated statement of operations. 10 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  11. 11. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 850D*/1695D Foot: 0D/ 0D VJ RSeq: 5 Clr: 0 5 C Cs: 18646 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 2—Restructuring, Asset Impairments and Other Costs (Continued) 1997 CHARGES The Company adopted a restructuring plan during the quarter ended June 30, 1997 related to the merger of Foundation Health Corporation and Health Systems International, Inc. (the ‘‘FHS Combina- tion’’), which created the Company, and a restructuring plan during the quarter ended December 31, 1997 related to the integration of the Company’s Eastern Division health plans (collectively the ‘‘1997 Plans’’). The principal elements of the 1997 Plans included a workforce reduction of approximately 1,235 employ- ees in 13 geographic locations, the consolidation of employee benefit plans, the consolidation of facilities in geographic locations where office space is duplicated, the consolidation of overlapping provider networks as required in obtaining regulatory approval for the FHS Combination, and the consolidation of information systems at all locations to standardized systems. The 1997 Plans resulted in restructuring costs totaling $149.5 million, net of modifications to the initial estimates of $42.0 million which were also recorded during 1997. As of September 30, 1999, the 1997 Plans are substantially complete with the remaining terminations of employees and settlement of remaining obligations expected to be completed prior to the end of 1999. During 1997, the Company also recorded merger costs of $69.6 million related to the FHS Combina- tion, costs of $57.5 million related to premium deficiency reserves at Gem Insurance Company, a Company subsidiary, and other costs of $12.6 million related to the loss on sale of the Company’s United Kingdom operations. The following two tables summarize the 1997 charges by quarter and by type (amounts in millions): Activity through December 31, 1998 1999 Activity 1997 Net Balance at Balance at Expected 1997 Modifications 1997 Cash December 31, Cash September 30, Future Cash Charges to Estimate Charges Payments Non-Cash 1998 Payments Non-Cash 1999 Outlays Severance and benefit related costs . . . . . . . . . $ 71.1 $ (9.7) $ 61.4 $ (51.9) $ (6.6) $ 2.9 $(0.8) $— $2.1 $2.1 Provider network consolidation costs . . . . . . . . . 44.3 (8.1) 36.2 (27.7) — 8.5 (5.5) — 3.0 3.0 Asset impairment costs . . . . . . . . . . . . . . . . 46.0 (2.0) 44.0 (5.4) (35.2) 3.4 — (1.1) 2.3 — Real estate lease termination costs . . . . . . . . . . 30.1 (22.2) 7.9 (5.0) — 2.9 (2.3) — 0.6 0.6 Total restructuring costs . . . . . . . . . . . . . . . 191.5 (42.0) 149.5 (90.0) (41.8) 17.7 (8.6) (1.1) 8.0 5.7 Merger related costs . . . . . . . . . . . . . . . . . 73.2 (3.6) 69.6 (64.8) (4.8) — — — — — Gem costs . . . . . . . . . . . . . . . . . . . . . . 57.5 — 57.5 (54.0) (3.5) — — — — — Other costs . . . . . . . . . . . . . . . . . . . . . . 12.6 — 12.6 — (12.6) — — — — — Total . . . . . . . . . . . . . . . . . . . . . . . . . $334.8 $(45.6) $289.2 $(208.8) $(62.7) $17.7 $(8.6) $(1.1) $8.0 $5.7 Second Quarter 1997 Charge . . . . . . . . . . . . . $328.8 $(45.6) $283.2 $(205.0) $(60.5) $17.7 $(8.6) $(1.1) $8.0 $5.7 Fourth Quarter 1997 Charge . . . . . . . . . . . . . 6.0 — 6.0 (3.8) (2.2) — — — — — Total . . . . . . . . . . . . . . . . . . . . . . . . . $334.8 $(45.6) $289.2 $(208.8) $(62.7) $17.7 $(8.6) $(1.1) $8.0 $5.7 11 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  12. 12. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 2705D /2840D Foot: 0D/ 0D VJ RSeq: 6 Clr: 0 5 C Cs: 44642 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 3—Comprehensive Income The Company’s comprehensive income for the third quarter and nine months ended September 30 is as follows (amounts in thousands): Third Quarter Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $35,089 $(88,619) $104,979 $(61,425) Other comprehensive income, net of tax— Net change in unrealized appreciation (depreciation) on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,439 6,039 5,337 7,215 Comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . $43,528 $(82,580) $110,316 $(54,210) Note 4—Earnings per Share Basic earnings per share excludes dilution and reflects income divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (all of which are comprised of stock options) outstanding during the periods presented; no adjustment to income is required. Common stock equivalents arising from dilutive stock options are computed using the treasury stock method. There were 423,000 and 157,000 common stock equivalents for the third quarter and nine months ended September 30, 1999, and no such common stock equivalents for the third quarter and nine months ended September 30, 1998. 12 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  13. 13. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 0D*/540D Foot: 0D/ 0D VJ RSeq: 7 Clr: 0 5 C Cs: 26283 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 5—Segment Information Presented below are segment data for the three and nine months ended September 30, 1999 and 1998 (amounts in thousands): Government Contracts/ Health Plan Specialty Services Services Other Total Three Months Ended September 30, 1999 Revenues from external sources . . . . . . . . . . . $1,761,510 $ 372,778 $ 26,987 $2,161,275 Intersegment revenues . . . . . . . . . . . . . . . . . . 94,013 — 6,690 100,703 Income (loss) before income taxes . . . . . . . . . 55,454 31,505 (28,618) 58,341 Three Months Ended September 30, 1998 Revenues from external sources . . . . . . . . . . . $1,769,291 $ 348,732 $ 20,441 $2,138,464 Intersegment revenues . . . . . . . . . . . . . . . . . . 85,540 — 6,253 91,793 Income (loss) before income taxes . . . . . . . . . (58,386) 25,744 (94,930) (127,572) Nine Months Ended September 30, 1999 Revenues from external sources . . . . . . . . . . . $5,277,588 $1,105,882 $ 115,368 $6,498,838 Intersegment revenues . . . . . . . . . . . . . . . . . . 267,943 — 20,538 288,481 Income (loss) before income taxes and cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . 114,485 88,337 (19,153) 183,669 Segment Assets . . . . . . . . . . . . . . . . . . . . . . . 2,470,084 1,043,502 (5,415)(a) 3,508,171 Nine Months Ended September 30, 1998 Revenues from external sources . . . . . . . . . . . $5,331,922 $1,017,595 $ 70,035 $6,419,552 Intersegment revenues . . . . . . . . . . . . . . . . . . 249,341 — 23,831 273,172 Income (loss) before income taxes . . . . . . . . . 13,627 89,438 (185,846) (82,781) Segment Assets . . . . . . . . . . . . . . . . . . . . . . . 2,511,790 908,347 449,046 (a) 3,869,183 (a) Includes $2,426,309 and $2,687,233 of assets related to corporate and other entities as of Septem- ber 30, 1999 and 1998, respectively, and $2,431,724 and $2,238,187 of intersegment eliminations as of September 30, 1999 and 1998, respectively. Note 6—Change in Accounting Principle Effective January 1, 1999, the Company adopted Statement of Position 98-5 ‘‘Reporting on the Costs of Start-Up Activities’’ and changed its method of accounting for start-up and organization costs. The change involved expensing these costs as incurred, rather than the Company’s previous accounting principle of capitalizing and subsequently amortizing such costs. The change in accounting principle resulted in the write-off of the costs capitalized as of January 1, 1999. The cumulative effect of the write-off was $5.4 million (net of tax benefit of $3.7 million) and has been expensed and reflected in the condensed consolidated statement of operations for the nine months ended September 30, 1999. 13 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  14. 14. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 200D*/240D Foot: 0D/ 0D VJ RSeq: 8 Clr: 0 5 C Cs: 16861 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 7—Disposition of Assets During the third quarter ended September 30, 1999, the Company completed the sale of its HMO operations in New Mexico, its two California hospitals and one of its bill review subsidiaries. For the sales of these businesses, the Company received net cash proceeds of $37.8 million, and notes receivable of $12.2 million. The sales of these businesses resulted in a net loss of $23,000, before taxes. On September 21, 1999, the Company executed a definitive agreement with PacifiCare of Colorado, Inc. to transition all of its membership in Colorado by March 31, 2000. The previously disclosed Letter of Intent with WellPoint Health Networks Inc. has expired. During the second quarter ended June 30, 1999, the Company completed the sale of its HMO operations in the states of Texas, Louisiana and Oklahoma and its preferred provider organization network subsidiary, Preferred Health Network, Inc. As part of the transactions, the Company received certain cash proceeds and convertible preferred stock. The Company recognized total losses on the sales of $5.8 mil- lion, before taxes, in the second quarter ended June 30, 1999. On March 31, 1999, the Company completed the sale of certain of its pharmacy benefits processing operations for net cash proceeds of $65.0 million and recognized a gain of $53.6 million, before taxes. On December 10, 1998, the Company completed the sale of the workers’ compensation segment which was accounted for as discontinued operations for the three and nine months ended September 30, 1998. The loss on disposition of $99 million recorded at December 31, 1997 included the anticipated results of discontinued operations through the date of disposition; accordingly, net losses of $4.2 million and $7.9 million related to the operations of the workers’ compensation segment are not reflected on the Company’s condensed consolidated statements of operations for the three and nine months ended September 30, 1998, respectively. Note 8—Legal Proceedings Complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. (‘‘FPA’’) at various times between February 3, 1997 and May 15, 1998. The complaints allege that the Company and certain former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 agreement between the Company and FPA, about FPA’s business and about the Company’s 1997 sale of FPA common stock held by the Company. Subsequent to the Company’s filing of a motion to dismiss all claims asserted against it in the consolidated federal class actions, all claims against the Company’s former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. Thereafter, all proceedings in the consolidated federal class actions were stayed and a motion to dismiss was denied without prejudice to renewal after the expiration of the stay. The stay has since expired and the Company intends to renew its motion to dismiss all claims asserted against it. Management believes these suits are without merit and intends to vigorously defend the actions. The Company and certain of it subsidiaries are also parties to various other legal proceedings, many of which involve claims for coverage encountered in the ordinary course of business. Based in part on advice from litigation counsel to the Company and upon information presently available, management of the 14 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  15. 15. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:11 DISK037:[99WLA8.99WLA1958]DI1958B.;24 DISK037:[99WLA8.99WLA1958]DI1958B.;24 mrll.fmt Free: 4100DM/0D Foot: 0D/ 0D VJ RSeq: 9 Clr: 0 5 C Cs: 11130 FOUNDATION HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (Unaudited) Note 8—Legal Proceedings (Continued) Company is of the opinion that the final outcome of all such proceedings should not have a material adverse effect on the financial position or results of operations of the Company. Note 9—Subsequent Events In October 1999, the Company entered into a definitive agreement to sell the capital stock of its HMO subsidiary in the State of Washington. The Company also entered into definitive agreements to transition its commercial membership in Washington to various third party HMO and insurance compa- nies. The Company anticipates completing the sale and transition by the end of April 2000. In addition, the Company completed the sale of its HMO operations in Utah during October 1999. 15 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DI1958B.;24 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  16. 16. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:14 DISK037:[99WLA8.99WLA1958]DK1958A.;16 DISK037:[99WLA8.99WLA1958]DK1958A.;16 mrll.fmt Free: 8D*/277D Foot: 0D/ 0D VJ RSeq: 1 Clr: 0 5 C Cs: 57644 ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foundation Health Systems, Inc. (together with its subsidiaries, the ‘‘Company’’) is an integrated managed care organization which administers the delivery of managed health care services. The Com- pany’s operations consist of two operating segments: Health Plan Services and Government contracts/ Specialty services. Through its subsidiaries, the Company offers group, individual, Medicaid and Medicare health maintenance organization (‘‘HMO’’) and preferred provider organization (‘‘PPO’’) plans; govern- ment sponsored managed care plans; and managed care products related to administration and cost containment, behavioral health, dental, vision and pharmaceutical products and other services. The Health Plan Services segment consists of HMOs organized into four operational divisions located in the following geographic regions: the California Division, the Northeast Division, the Central Division and the Arizona Division. During the nine months ended September 30, 1999, these health plans were located in Arizona, California, Colorado, Connecticut, Florida, Idaho, New Jersey, New York, Ohio, Oregon, Pennsylvania, Utah, Washington and West Virginia. The Company sold its HMO operations in the states of Louisiana, Oklahoma and Texas effective April 30, 1999 and in the state of New Mexico effective September 30, 1999. The Company’s health plans provide a wide range of managed health care services throughout the United States with approximately 4.0 million at risk and administrative services only members. The Company’s HMO subsidiaries contract to provide medical care services to a defined, enrolled population for a predetermined, prepaid monthly fee for group, individual Medicare and Medicaid plans throughout their respective service areas. All of the HMOs are state licensed and some are also federally qualified. The Company also operates PPO networks which provide access to health care services and owns five health and life insurance companies licensed to sell insurance throughout most of the United States. The financial results include the results of the two California hospitals through August 31, 1999, the date they were sold. The Government contracts/Specialty services segment administers large, multi-year managed health care government contracts. This segment subcontracts to affiliated and unrelated third parties the administration and health care risk of parts of these contracts and currently administers health care programs covering approximately 1.5 million eligible individuals under the Civilian Health and Medical Program of the Uniformed Services (‘‘CHAMPUS’’) through the TRICARE program. Currently, the Company provides these services under three TRICARE contracts that cover Alaska, Arkansas, Califor- nia, Hawaii, Oklahoma, Oregon, Texas, Washington and parts of Arizona, Idaho and Louisiana. This segment also offers behavioral health, pharmacy management, dental and vision services and sub-acute hospital unit management as well as managed care and workers’ compensation products related to bill review, administration and cost containment for hospitals, health plans and other entities. This discussion and analysis contains ‘‘forward-looking statements’’ within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from those projected or implied in these statements. The risks and uncertainties faced by the Company include, but are not limited to, those set forth under ‘‘Additional Information Concerning the Company’s Business,’’ ‘‘Cautionary Statements’’ and other sections within the Company’s filings with the Securities and Exchange Commission. CONSOLIDATED OPERATING RESULTS The Company’s net income for the third quarter ended September 30, 1999 was $35.1 million, or $0.29 per basic and diluted share, compared to a net loss for the comparable period in 1998 of $88.6 million, or $0.73 per basic and diluted share. The Company’s net income for the nine months ended September 30, 1999 was $105.0 million, or $0.86 per basic and diluted share, compared to a net loss for the comparable period in 1998 of $61.4 million or $0.50 per basic and diluted share. Excluding the cumulative effect of the change in accounting principle for organization and start up costs recorded during the first quarter of 1999, net income was $110.4 million or $0.91 per basic and diluted share for the nine months ended September 30, 1999. 16 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DK1958A.;16 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  17. 17. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:14 DISK037:[99WLA8.99WLA1958]DK1958A.;16 DISK037:[99WLA8.99WLA1958]DK1958A.;16 mrll.fmt Free: 158D*/2090D Foot: 0D/ 0D VJ RSeq: 2 Clr: 0 5 C Cs: 28271 The table below and the paragraphs that follow provide selected financial information related to the Company’s performance for the three and nine months ended September 30, 1999 and 1998. Certain 1998 amounts have been reclassified to conform with the current period presentation. In the second and third quarters ended June 30, 1999 and September 30, 1999, respectively, the Company reclassified and adjusted certain intercompany revenues and expenses which did not impact net income or earnings per share. The reclassifications did result in higher reported revenues in its Government contracts/Specialty services unit and lower reported revenues and costs in its Health Plan Services unit compared with amounts previously disclosed. FHS believes this more accurately reflects the performance of its specialty companies as if they were independent entities. In addition, in the first quarter ended March 31, 1999, the Company reclassified medical management expenses from health plan medical expenses to selling, general and administrative expenses (‘‘SG&A’’) and also recorded SG&A expenses of its Specialty services businesses in SG&A, rather than in Government contracts/Specialty services costs as had been the case in prior periods. Third Quarter Ended Nine Months Ended September 30, September 30, September 30, September 30, 1999 1998 1999 1998 (amounts in thousands, except per member per month amounts) Revenues: Health plan premiums . . . . . . . . . . . . . . . . . . . $1,761,510 $1,769,291 $5,277,588 $5,331,922 Government contracts/Specialty services . . . . . . 372,778 348,732 1,105,882 1,017,595 Investment and other income . . . . . . . . . . . . . . 27,010 20,441 67,643 70,035 Net gain (loss) on sale of businesses sold . . . . . . (23) — 47,725 — Total revenues . . . . . . . . . . . . . . . . . . . . . . . 2,161,275 2,138,464 6,498,838 6,419,552 Expenses: Health plan services . . . . . . . . . . . . . . . . . . . . . 1,495,784 1,551,072 4,470,578 4,527,221 Government contracts/Specialty services . . . . . . 244,326 232,346 725,220 657,388 Selling, general and administrative . . . . . . . . . . 314,008 354,706 950,597 1,033,412 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . 17,574 20,276 52,350 58,189 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . 10,505 12,323 32,033 36,756 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,737 23,626 63,332 67,680 Asset impairment and other charges . . . . . . . . . — 71,687 21,059 121,687 Total expenses . . . . . . . . . . . . . . . . . . . . . . . 2,102,934 2,266,036 6,315,169 6,502,333 Income (loss) before income taxes and cumulative effect of change in accounting principle . . . . . . . 58,341 (127,572) 183,669 (82,781) Income tax provision (benefit) . . . . . . . . . . . . . . . 23,252 (38,953) 73,273 (21,356) Income (loss) before cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . 35,089 (88,619) 110,396 (61,425) Cumulative effect of change in accounting principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 5,417 — Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $ 35,089 (88,619) $ 104,979 $ (61,425) Administrative (SG&A + Depreciation) Ratio . . . 15.54% 17.70% 15.71% 17.19% Health plan MCR . . . . . . . . . . . . . . . . . . . . . . . . 84.91% 87.67% 84.71% 84.91% Government contracts/Specialty services MCR . . . . 65.54% 66.63% 65.58% 64.60% Overall MCR . . . . . . . . . . . . . . . . . . . . . . . . . . . 81.53% 84.20% 81.39% 81.65% Health plan premiums per member per month . . . $ 139.65 $ 128.61 $ 138.10 $ 127.35 Health plan services per member per month . . . . . 118.58 111.88 116.99 108.13 17 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DK1958B.;18 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  18. 18. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:14 DISK037:[99WLA8.99WLA1958]DK1958B.;18 DISK037:[99WLA8.99WLA1958]DK1958B.;18 mrll.fmt Free: 60D*/120D Foot: 0D/ 0D VJ RSeq: 3 Clr: 0 5 C Cs: 65047 Enrollment Information September 30, 1999 (Amounts in Thousands) Percent 1999 1998 Change Health Plan Services: Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,045 3,361 (9.4)% Medicare Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 323 (17.3)% Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 676 555 21.8 % 3,988 4,239 (5.9)% Government Contracts: CHAMPUS PPO and Indemnity . . . . . . . . . . . . . . . 661 783 (15.6)% CHAMPUS HMO . . . . . . . . . . . . . . . . . . . . . . . . . 840 685 22.6 % 1,501 1,468 2.2 % Revenues and Health Care Costs The Company’s revenues increased by $22.8 million or 1.1% for the third quarter ended Septem- ber 30, 1999 and $79.3 million or 1.2% for the nine months ended September 30, 1999 as compared to the comparable periods in 1998. Health Plan revenues decreased $7.8 million and $54.3 million for the third quarter and nine months ended September 30, 1999, respectively, as compared to the comparable periods in 1998. This was due primarily to decreases in enrollment partially offset by increases in premium rates. In addition, for the third quarter and nine months ended September 30, 1999, the Company’s Health plan revenues include $23.4 million and $93.3 million, respectively, from its subsidiaries that have been sold during the first nine months of 1999, as compared to $42.2 million and $133.7 million for the same subsidiaries during the third quarter and nine months ended September 30, 1998. See ‘‘Segment Informa- tion—Health Plan Services’’ for further discussion. Growth in Government contracts/Specialty services revenues totaled $24.0 million and $88.3 million for the third quarter and nine months ended September 30, 1999, respectively, as compared to the comparable periods in 1998. This growth is primarily due to increases in government contracts membership and growth in the managed behavioral health network. See ‘‘Segment Information—Government Con- tracts/Specialty Services’’ for further discussion. Included in total revenues for the nine months ended September 30, 1999 is a $47.7 million net gain on the sale of certain businesses during the first nine months of 1999. The overall medical care ratio (‘‘MCR’’) (medical costs as a percentage of Health Plan premiums and Government contracts/Specialty services revenues) for the third quarter and nine months ended Septem- ber 30, 1999 was 81.53% and 81.39%, respectively, as compared to 84.20% and 81.65%, respectively, for the comparable periods in 1998. Excluding the other charges as discussed in Note 2 to the accompanying condensed consolidated financial statements, the MCR would have been 80.08% and 80.28% for the third quarter and nine months ended September 31, 1998, respectively. There were no such adjustments in 1999. The increase in the MCRs was primarily due to increased pharmacy costs in most of the Company’s health plans, partially offset by increases in premium rates. See ‘‘Segment Information’’ for further discussion. Selling, General and Administrative Costs The Company’s selling, general and administrative (‘‘SG&A’’) expenses decreased by $40.7 million or 11.5% for the third quarter ended September 30, 1999 as compared to the comparable periods in 1998, and $82.8 million or 8.0% for the nine months ended September 30, 1999 as compared to the comparable 18 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DK1958B.;18 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  19. 19. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:14 DISK037:[99WLA8.99WLA1958]DK1958B.;18 DISK037:[99WLA8.99WLA1958]DK1958B.;18 mrll.fmt Free: 290D*/300D Foot: 0D/ 0D VJ RSeq: 4 Clr: 0 5 C Cs: 32072 periods in 1998. Excluding the restructuring and other charges, the SG&A expenses decreased by $25.5 million and $67.7 million for the third quarter and nine months ended September 30, 1999. The divestiture of non-core plans accounted for approximately $13.9 million and $25.6 million of the decrease for the third quarter and nine months ended September 30, 1999, respectively. The remaining decrease in SG&A expenses during 1999 is primarily attributable to the Company’s ongoing efforts to control its SG&A expenses. Amortization and Depreciation Amortization and depreciation expense decreased by $4.5 million and $10.6 million for the third quar- ter and nine months ended September 30, 1999, respectively, as compared to the comparable periods in 1998. The decrease is due to the $30.0 million write-down of goodwill and other long-lived assets to their estimated fair value during the year ended December 31, 1998 and the write-off of organization and pre-operating costs of $9.1 million during the first quarter ended March 31, 1999. Interest Expense Interest expense decreased by $2.9 million and $4.3 million for the third quarter and nine months ended September 30, 1999, respectively, as compared to the comparable periods in 1998. A decrease in interest expense from the reduction in the revolving credit facility balance was partially offset by a higher average borrowing rate of 6.7% in 1999 as compared to 6.1% in the comparable period in 1998. Income Tax Provision and Benefit The effective tax provision rate was 39.9% on income from operations for the third quarter and nine months ended September 30, 1999, respectively, compared to the effective tax benefit rate on continuing operations of 30.5% and 25.8%, respectively, for the comparable periods in 1998. The difference from the statutory tax rate is primarily due to California state taxes which only benefited 50% of the prior year losses and permanent differences related to tax-exempt investment income. Restructuring and Other Costs The Company initiated a formal plan to dispose of certain Central Division health plans included in the Company’s Health Plan Services segment in accordance with its anticipated divestitures program in the fourth quarter of 1998. In this connection, the Company announced its plan to close the Colorado regional processing center, terminate employees and transfer its operations to the Company’s other administrative facilities. In addition, the Company announced it plans to consolidate certain administrative functions in its Northwest health plan operations. During the quarter ended March 31, 1999, the Company recorded pretax charges for restructuring and other charges of $21.1 million. SEVERANCE AND BENEFIT RELATED COSTS—The 1999 Charges included $18.5 million for sever- ance and benefit related costs related to executives and operations employees at the Colorado regional processing center and operations employees at the Northwest health plans. The operations functions include premium accounting, claims, medical management, customer service, sales and other related departments. The 1999 Charges included the termination of a total of 773 employees. As of September 30, 1999, 388 employees had been terminated and $5.8 million had been paid. Termination of the remaining 385 employees is expected to be completed during the first half of 2000. No adjustments to the original estimates recorded have been identified as of September 30, 1999. REAL ESTATE LEASE TERMINATION AND OTHER COSTS—The 1999 Charges included $0.8 million to terminate real estate lease obligations and $1.8 million in other costs to close the Colorado regional processing center. 19 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DK1958B.;18 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha
  20. 20. MERRILL CORPORATION NETWORK COMPOSITION SYSTEM AOSBORN//15-NOV-99 12:14 DISK037:[99WLA8.99WLA1958]DK1958B.;18 DISK037:[99WLA8.99WLA1958]DK1958B.;18 mrll.fmt Free: 110D*/120D Foot: 0D/ 0D VJ RSeq: 5 Clr: 0 5 C Cs: 19621 During 1998, the Company recorded charges primarily related to the bankruptcy of FPA Medical Management, Inc. (‘‘FPA’’), the centralization and consolidation of the Company’s corporate finance and human resources functions, and the impairment of certain long-lived assets held for disposal as a result of the Company’s anticipated divestiture program approved in the fourth quarter of 1998. During the third quarter ended September 30, 1998, the Company recorded severance costs of $21.2 million related to staff reductions in selected health plans and corporate centralization and consolidation. This plan includes the termination of 683 employees in 7 geographic locations primarily relating to corporate finance and human resources functions and California operations. As of Septem- ber 30, 1999, 570 employees had been terminated and termination of the remaining 113 employees is expected to occur during the fourth quarter of 1999. On July 19, 1998, FPA Medical Management, Inc. (‘‘FPA’’) filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. FPA, through its affiliated medical groups, provided services to approximately 190,000 of the Company’s affiliated members in Arizona and California and also leased health care facilities from the Company. FPA has discontinued its medical group operations in these markets and the Company has made other arrangements for health care services to the Company’s affiliated members. The FPA bankruptcy and related events and circumstances caused management to re-evaluate the decision to continue to operate the facilities and management determined to sell the 14 properties, subject to bankruptcy court approval. Management immediately commenced the sale process upon such determination. The estimated fair value of the assets held for disposal was determined based on the estimated sales prices less the related costs to sell the assets. Management believed that the net proceeds from a sale of the facilities would be inadequate to enable the Company to recover their carrying value. Based on management’s best estimate of the net realizable values, the Company recorded charges of $50.0 million during the second quarter of 1998, $28.1 million during the third quarter of 1998 and $6.0 million during the fourth quarter of 1998. These charges were comprised of $63.0 million for real estate asset impairments, $10.0 million impairment adjustment of a note received as consideration in connection with the 1996 sale of the Company’s physician practice management business and $11.1 million for other items. These other items included payments made to Arizona physician specialists totaling $3.4 million for certain obligations that FPA had assumed but was unable to pay due to its bankruptcy, advances to FPA to fund certain operating expenses totaling $3.0 million, and other various costs totaling $4.7 million. The carrying value of the assets held for disposal totaled $12.4 million at September 30, 1999. As of September 30, 1999, ten properties have been sold which has resulted in net gains of $4.4 million during 1999 and $3.6 million in 1998. The remaining properties are expected to be sold during the fourth quarter of 1999. The suspension of real estate depreciation has an annual impact of approximately $2.0 million. During the fourth quarter ended December 31, 1998, excluding $6.0 million related to the FPA bankruptcy discussed above, the Company recorded impairment and other charges totaling $112.4 million. During the fourth quarter of 1998, the Company initiated a formal plan to dispose of certain Central Division health plans included in the Company’s Health Plan Services segment in accordance with its previously disclosed anticipated divestitures program. The sale of most of these health plans has occurred during the nine months ended September 30, 1999 with the remaining health plans and real estate expected to be sold by the end of 1999. The Company evaluated the carrying value of the assets for these health plans and the related service center and holding company, and determined that the carrying value of these assets exceeded the estimated fair value of these assets. Accordingly, in the fourth quarter of 1998, the Company adjusted the carrying value of these long-lived assets to their estimated fair value, resulting in a non-cash asset impairment charge of approximately $112.4 million. This asset impairment charge of $112.4 million consisted of $40.3 million for write-downs of abandoned furniture, equipment and software development projects, $20.9 million for write-down of buildings and improvements, $30.0 million for write-down of goodwill and $21.2 million for other impairments and other charges. The fair value was based on expected net realizable value. Revenues and pre-tax income attributable to these plans identified 20 FOUNDATION HEALTH 10-Q (9-30-99) Proj: P1023WLA99 Job: 99WLA1958 File: DK1958B.;18 Merrill/West Los Angeles (310)475-4418 EDGAR Page Dim: 8.250 X 10.750 Copy Dim: 38. X 54.3 Alpha

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